As the new year begins, with changing economic data and monetary policy, the future is full of uncertainty, but analysts are optimistic about the outlook for the euro.
The euro has rebounded in recent months after falling below parity with the dollar in the second half of 2022. It hovered in a narrow range just above $1.07 on Wednesday (11th) morning.
The euro’s weakness last year came as the Fed aggressively tightened monetary policy, while the European Central Bank was slow to raise rates to curb runaway inflation.
However, several analysts highlighted this week that incoming data trends point to the need for the EU to remain hawkish, while U.S. rate hikes may be tempered. The narrowing of interest rate differentials will benefit the euro.
In addition, much of northern Europe experienced an unusually mild winter and the threat posed by high energy prices has receded.
“The euro remains range-bound in late December, but data from early 2023 suggests the euro should strengthen,” Steve Englander, global head of G-10 FX research at Standard Chartered, said in a note. Both energy and economic bullishness continue to strengthen, making it easier for the ECB to maintain a hawkish tone. Energy concerns that are negative for the euro in mid-2022 are also starting to fade.”
Preliminary data released last week by Eurostat showed headline annual inflation in the euro zone slipped to 9.2 percent in December from 10.1 percent in November, but core inflation, which excludes volatile energy, food, alcohol and tobacco prices, fell to 9.2 percent in December. It rose more than expected, hitting an all-time high of 5.2%.
Both the ECB and the Fed have maintained a hawkish tone in recent weeks, focusing on bringing inflation back to target. “Policy rates will have to rise sharply further to reach sufficiently restrictive levels to ensure that inflation returns to the medium-term target of 2 percent in time,” ECB member Robert Holzmann said at a meeting on Wednesday.
However, Englander noted that the U.S. data was “moderately weaker” than Europe’s, suggesting less upward pressure on interest rates.
He highlighted that the latest EU average hourly earnings (AHE) trend was “much more benign” than the FOMC data in mid-December; November’s six-month annualized profit growth was up 5.3% . But growth slowed to 4.4 percent in December. December’s non-manufacturing ISM was the lowest since 2010.
Fed Chairman Jerome Powell has repeatedly stressed the importance of wages in reducing inflation in core services, citing wage growth as a risk factor in the Fed’s mandate to reduce inflation.
“If the labor productivity growth trend remains unchanged from pre-pandemic to today, this would put AHE growth in line with underlying inflation of 3-3.5%,” Englander said. 3.5% wage growth in line with inflation is not a serious inflation problem, especially if wage trends continue to trend lower.”
Lower core services inflation would give the Fed room to halve its aggressive rate-hike cycle this year, and possibly even begin to reverse it.
